The Massive Passive Income Problem

When I started investing in real estate in 2001 I had two main objectives: get my money working hard for me so I didn’t always have to work hard for my money AND create multiple streams of passive income.

Holding rental properties seemed like such a simple way to create passive income. Buy a house, put a tenant in there, and collect rent. Easy as making a pie. Or so I thought.

And, you know what? It actually is pretty simple. And it’s definitely enabled myself and my husband Dave to enjoy a lot more freedom than any job ever could. We are making money from our properties each and every month and each property grows our wealth a little (and sometimes a lot) each year. Once upon a time we would have said we are earning thousands of dollars each month in passive income, but we no longer do.

The problem with pursuing “passive income” is that you’re telling yourself you don’t have to do any work to make that money.

Keith Cunningham, author of Keys to the Vault says, “The label becomes the experience. Using the word passive for anything means that you are going to do the least to get the most.”

That might sound like a great idea but the problem is that trying to build wealth through passive income is like trying to get six-pack abs without working out. It isn’t going to happen. You can’t do nothing and expect to get positive results.

We worked hard to find the properties, bought them, and then passively let things fall apart!

Now, my husband Dave reviews all the bills and talks to our property managers on a regular basis. For the properties we manage ourselves, we do regular walk-throughs and monitor any bills that are sent our way. We both carefully track and monitor the money that gets spent on each building.

Doing this is far from a full-time job. It really doesn’t require a lot of time and attention. When things are running smoothly it takes less than an hour or two a month for each property to measure, monitor, and adjust to maximize our profits and minimize our struggles and expenses. We no longer believe it’s a passive income source – one could call it leveraged and it definitely has a very high return on time invested – but we do not call it passive. And since we stopped considering real estate to be a passive income stream, we have less problems and we make a whole lot more money!

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38 Comments

ITs like taxes. If you are a salaried guy, you never get wealthy cause the gov takes their share. They take the cream off the top much like property mangers do. I kow Julie that you dont like propertymanagment much but it really doesnt take that much time. Take another look at it.
After 15 yrs of having both PMs and having some of my houses managed my me, I see the skim the PMS take. Its hard to get ahead wit ha PPM that spend more money than you do on a property.
Properties I have that are managed by PMs go vacant more, take longer to rent, more money spent on repairs, have less cash flow and get trashed way more than with the tenants I select.

Thanks Steve!! The tax advantages of being self employed and/or a real estate investor are tremendous. It really is one of the great advantages that isn’t talked about nearly enough.

As for property management – my husband Dave does oversee all the properties we have that are rent to own. Our regular buy and holds – especially the ones that are far away – are all under property management and we don’t intend to change that. We know we would take better care of them and probably make a bit more money on them if we oversaw them but we also have to factor in the time and effort it takes to do that … our time is the ONLY resource we have that we can’t get more of!

Words any landlord can relate too. Very few jump into being a landlord with out the thought of some easy money. Maybe that’s why when reality sets in, few make it past 3-4 years.
“Wealth is created where man exerts energy” George S. Clason

Actually I don’t. Its a number Ive seen thrown around a bunch, but I just spent a few minutes looking and could not find any stats. I would be interested in seeing the true numbers myself. Very good question.

I don’t agree. You have so many people who exert energy but have nothing to show for it. Buffet talked about this. A soldier who shows a great deal of courage and saves several lives receives a medal. A hardworking teacher who helps her students succeed sometimes gets thank-you notes from parents. Someone who is very good at valuing securities and can act on opportunities can receive millions or billions of dollars. Is the security trader a lot more hardworking than the soldier or teacher? Maybe, maybe not. Unless wealth is defined as non-financial and pertaining not to the individual but society, then that statement isn’t true.

Thanks for ‘re-defining’ what it is we do Julie. You are totally correct and I stopped calling it passive more than a year ago when some people suggested all I did was ‘go to the bank once a month to deposit cheques’. The one thing I DO TRY however is make is as passive as possible for my joint venture partners..

Joey – what an important point you bring up – we also do everything we can to ensure it’s passive for our partners. Once the papers are signed and the deal is closed we truly want it to be a passive experience. THAT SAID – we still encourage them to check up on us so to speak. We send them reports twice a year and email updates in between and encourage questions. It’s about as passive as it can be… but I still encourage them to be involved to an extent to make sure we’re taking good care of their money!

I never use the term ‘passive income’, because as per your point, there is nothing passive about investing. I think that the more ‘passive’ someone becomes with their real estate investing, as you so accurately mentioned, the more trouble people can get into. Just because somebody has a property manager does by no means mean that they can take their eye off the ball.

As I look ahead to the future, I can say with certainty that ‘passive income’ will still not be a term that I will use. As we know, there will always be work involved in maintaining real estate. Whether I am managing my property manager at that point, or whether I am managing the units myself, there will be work required. Albeit, hopefully not a great deal of work, however, there will still be work involved.

My personal favourite (Canadian spelling) with regards to generating a ‘passive income’ through rental properties is when I speak to people with very limited to no experience with real estate investing. The moment that they find out or when I tell them that I own multiple properties, they make a joke that I should be retired. I then have to explain to them that I cannot retire off X cash flow per month that the properties are generating. Nor would I want to as I like my day job. =)

Thanks Neil!! Great comments … and it would be an honour to have you as President of my Fan Club. You rock! And I would see favourite spelled no other way.

By the way, the more properties you get the more systems you’ll put into place to manage them. I am not saying each one won’t be a little more work but it won’t be twice as much every time you add one … I’m sure you’ve already discovered that … but just saying! One of the biggest changes we made this year is the addition of a bookkeeper and I have to say WHAT THE HECK WERE WE WAITING FOR?!!! What a big difference that has made!!!

The more and more I look into “passive income” streams, the more I realize that there is no passive about any of them. They all require hard work at some point in the process and then less work to maintain. It’s like getting into shape. At first, when you are out of shape you have to work your ass off to build up your stamina and your muscles, but once you reach the point you are happy with you can back off some and just maintain.

Another awesome exercise analogy … I love it!! It’s SOOOOO true. When you first start anything it’s always difficult but over time it gets easier and takes less time. WOOHOOO!! Thanks Scott. And by the way, having had many massive wipeouts going downhill I can say with 100% certainty it ain’t passive!!!!!!!!! You still have to maintain control.

Yeah, nothing comes from nothing, that’s for sure. I remember reading your article about the nightmare property manager and I couldn’t agree more that “passive” is never the best attitude if you want something to pay off.

All true. From one of my first blog postings (and experiences!):
Lesson #1: Do not believe those ads!
You will not sit home and collect rent from your tenants. It will not be Passive Income, nor will it run itself.
A building looks solid, but it’s really a mystic being, undulating with wants and needs. It will need maintenance, painting, garbage removal, lawn cutting, snow shoveling. It will cry through its plumbing, get chills through its heating system, have fevers through its air-conditioning system. And, like a spurned lover, will often have late-night tirades.
You will be called about all of it.
You will often be a babysitter, referee, detective, and psychologist.
You will need to be an appraiser, handyman, bookeeper.
If you do all this well, you may make money.
It’s a business. Better to know this ahead of time.

Half of that is not my experience. I like houses cause the tenant is the property manager. My phone does not ring at night, it rarely rings at all. In California, no need for snow removal, half my houses need no AC for the weather is so nice, we have wall panel heat-very simple and does not break down. We only hire tenants who own a toll box and have lawn equipment. We expect a very high standard of housekeeping at all times.
THose late night tirades? I dont get called on any of it but thats just my experience

I don’t get late night calls but that’s because I don’t manage the properties myself.
I do believe that it’s good to be aware that all that can happen Mary and it has happened to us for sure. But we adjusted our strategy to minimize it. I have to say – because we buy great homes in good areas that attract really awesome people (and we carefully screen to find great people) we actually get very very few calls from tenants at all now. Most of my bad tenant and property management nightmare stories are from over 5 years ago. But I totally agree with you – it’s a business and it’s definitely not passive and there are definitely moving parts to be dealt with (you never fix just one thing one time on a house if you own it for long enough) but it doesn’t have to be all consuming either!! Thank goodness because it gives me lots of time to write, coach other investors, ski and mountain bike! The stuff I REALLY love to do.

Houses are great, but around here, after expenses, you’d have negative cash flow on a house rental until you owned it a long time. Meanwhile, you could go broke before that happened. So we usually bought multi-family buildings, which means the landlord is responsible for common area maintenance. Plus, we were just kids when we started, so we bought what we could afford. Even with decent tenants, that meant old housing stock in need of upgrading and repairs. It was way harder when we started than when we maxed out at 175 units, because by then we had systems and people working. So that was a blog entry for people considering being a landlord–you know, those who still believe in “passive income”.
Meanwhile, I always said if I were an orphan & didn’t have family I wanted to be near, I’d live in a warmer climate. I guess those instincts were right.

Very true, Julie! Real estate is like any business – it must be managed properly. With poor management, any business is likely to fail.

Honestly, it’s a lot of work but to me – it’s fulfilling. There have been times where I’ve worked more in this business than in any other job. A lot of sacrifices have been made, it’s definitely not like a regular 9-5 job.

When I first started out, I remember working 7 days a week. Even this week, I had a day where I was up at 6am to go and meet with a park manager. I was at the parks all day and did not get home until 6pm. So, it was a 6am-6pm day for me – straight through.

To be honest, many people I know (who work regular, 9-5 jobs) tell me it’s crazy to have this kind of work schedule and it would be easier to just have a high paying, regular 9-5 job. That way, I’d know what to expect by having set hours and can have time to “enjoy life.”

But, to me – I really enjoy running a business. I like meeting with people such as park managers and sellers and being out in the field. It definitely depends on me and my ability to build and maintain relationships with other people. For me, I enjoy this kind of work. If I’m going to work hard, I’d rather work hard for myself than for someone else. Just my view.

Hey Joel – we get billed once a year so I am actually not 100% sure. But we definitely paid quite a bit extra just to get it set up because we had to make some adjustments to how we were doing everything in order to make it worth with the bookkeeper. The ongoing monthly fees – excluding the accountants time – will probably be $200 – $300 a month. The fees for the accountant to prepare our bi annual statements for our JV partners and our corporate and personal tax returns will be more.

Sounds expensive at first glance but it’s saving us a TON of time monthly, and annually. Plus it was stuff we both HATED to do and we weren’t that good at it so it makes our lives more pleasant too!!

Great point you made about “passive” income. It’s commonly misunderstood (especially from books written by Robert Kiyosaki and others) by new investors. Luckily I grew up painting walls, fixing toilets, and driving to Sacramento to improve my parents properties when I was a little kid. I never…ever…thought that the income from our duplexes was passive nor did I want anyone else managing them but myself. (although I understand why you hired a property manager for out-of-state property…your time IS worth it don’t you think?)

I totally agree that a book keeper is worth it but I would venture to say that my parents have gone through numerous CPA’s in the past and still check their work every month so I wouldn’t be surprised if you have to hire different CPA’s over time.

One positive note to add to Rachel’s comment is that generally yes, most people who run their own businesses enjoy working for themselves then others even if they don’t get paid as much. I know, I’ve seen, and I’ve met businesses owners who love their businesses or not don’t much, get paid more in their business then employees do or don’t and some who work 70 hours a week and others who work 20 hours a week. “They come in all shapes and sizes.”

But the biggest benefit to Rachel’s (and any any business owners) hard work is that you can pass down your business to your kids….but you can’t pass down a job to your kids….of course except some house chores. (tax benefits are nice too)

Great comment Peter!!! And you’re right … we just changed accountants this year. We outgrew our previous accountant. I actually wrote about that this year I just can’t seem to figure out if it was for BP or my own blog!!

Anyway – we used to use a small business accountant. The one Dave’s family had been using for years but we found that we had to teach him about rent to owns and some of the deals we were doing were just getting too complicated for him. We needed a real estate specific accountant so that we were getting the right advice. We made the switch this year and it’s been such a smart move – another one of those things I wish we had done sooner!!

Also … this is such a big point: But the biggest benefit to Rachel’s (and any any business owners) hard work is that you can pass down your business to your kids….but you can’t pass down a job to your kids….of course except some house chores. (tax benefits are nice too) .

My parents were always into commercial real estate and ran a motel. I worked for them from a very young age. They didn’t pay me an allowance with after tax income they paid me wages from their business for the chores I did around the motel. Tax write off for them and money in my pocket!! If your kids mow the lawn at your rental properties that is such a tax benefit for you … and an allowance for them!! GREAT POINT!! Thank you!!!

So at what number of rentals did you find the need to have an accountant and a bookkeeper?

This seems like another cost I will be factoring into the buying equation along with PM fees etc.
I don’t want to do property management.Many of the client s I list and sell for I see how much hands on they have to be to save the management fee.A better use of my time is listing and closing sales.I can find competent property managers rather easily with my contacts.

Here property management runs first months rent and 10% of monthly collected rents.If they do an excellent job I don’t mind paying them the fee.

Hi Joel,
You know the decision was less about number of rentals than it was about the amount of time we were spending that could be better spent somewhere else. That and the fact that where we used to keep up with the revenue and expense sheets on a monthly basis it had slipped to almost annually making tax time a brutal experience. We had just found over time that we both REALLY disliked it, did a mediocre job of it, and could dedicate our time in other areas that would make this expense worthwhile.

Looking back …knowing what I know now … I would probably have brought on a bookkeeper after property #5.

I use property managers for my houses and apartment, and find that I have to stay on top of things. I read the utility bills every month, and review all the expenses. Last month, I found an increase in the water bill and put the property manager on it. She ended up finding a leak in one of the faucets. I would love for the property manager to catch these things, and I’d love to be able to quit my job and fire the property manager, but on the practical side of things, I need to let the run it, and audit each month.

Hi David – This is such an important thing! We had the same issue … Dave noticed the water bill on one of our rental properties was double what it usually is. He immediately contacted our property manager and asked that it be checked out. The property manager initially told us it was because the billing frequency had decreased. We were now being billed fewer times so it was expected that our bills would be double when we were billed.

Because we own properties in 4 different cities Dave wasn’t sure but he seemed to remember that change had occurred over a year ago. He pulled up our property expense tracking spreadsheet and sure enough – we’d moved to bi-monthly billing over a year ago.

He called our property manager back and insisted they investigate. Turns out we had a water leak. The leak was quickly fixed and the next water bill was back around what it usually is. We pay the utilities on that place and missing that leak would have cost us a big chunk of our positive income on that property each month.

You do have to keep an eye on things!! And funny enough … having a bookkeeper that prepares statements for you on a regular basis does make it easier to spot irregularities like this too.

I guess this is the price you pay for getting someone else to do your dirty work. An agent I used kept on rolling forward rents each month by a few days, until by the end of the year I was missing one whole months rent. The question that passive income investors will be asking is: Are you worse of with the risks of a rogue agent ripping you off than earning 1% on CDs, due to the machinations of much bigger rogues?

Haha!! Great question Joe … and most people are honest!!! But – and I’ve said this so many times – no matter how great someone is at their job NOBODY WILL LOVE YOUR MONEY LIKE YOU DO!! So you have to watch over it.

A question to you all I am wondering about. On the property managers are these actual managers that do management full time and hold the IREM certifications depending on what they are managing??

If not are these simply real estate brokers or agents who manage a few rentals on the side??

Do you vet these property managers and go to a lunch with them and ask questions,get references,and call and follow up on those references from other landlords??

If I have a property manager I want someone who does it full time and represents their main source of income and their LIVELIHOOD. I don’t want someone who is doing it for extra coin or they couldn’t cut it in sales and as soon as something else comes along they stop caring about your property.

This is why I ask when I hear these nightmare stories.I know you can’t catch all the bad apples but are landlords picking the right managers and putting them through a screening process as vigorous as the tenants??

Joel – you make some excellent points and I would love to tell you that many of my nightmare stories came as a result of us not doing enough due diligence but that is not always the case. We don’t have the IREM certifications you’re talking about in Canada – to my knowledge – but there are associations and things that we look for our property managers to be a member of in some cases.

We’ve had 3 poor managers in total. Not bad for all the homes we have had over the years and still have and the fact that we have managers in three different cities.

Not to say we weren’t to blame at all. 2 of the poor property managers were ones we could have done better due diligence on – although we did do some. The third one has actually become poor over time. He was fabulous for nearly 6 years but then he bought out his biggest competitor and let his sons begin running much of the business. Things have completely gone downhill and we’ve been moving poor performing properties out of their care. We only have 2 left with them where they once managed everything we own in our main investment market. So even once a good manager does not mean always a good manager.

No matter how much due diligence you do on a manager you shouldn’t ever let yourself believe it’s passive income … you still have to watch over what is happening.

I’d love to hear other people’s thoughts on this too!! Great questions Joel. Thank you!

Great post and great comments on this one! There is always a struggle, for me anyway, with how much of the work I farm out versus do myself. As we buy a property per month, I can no longer “do everything” and so on one hand, our real estate investing may become a bit more “passive” given that I won’t be doing everything anymore. However, as Julie and Rachel mentioned above, investing in real estate really is running a small (or even large) business. You can’t just walk from it…but if you put the right people and systems in place, you can make it a bit more “hand’s off”. But, it never EVER should be considered passive. The day it becomes that way is the day you start losing out on extra profits and revenue!

And you can run your business from anywhere once you get the systems in place!! That part is pretty cool … especially with banking technology online and mobile apps now right?? Thanks for your comment!!!

Completely agree with you Dave & Julie, although it isn’t 100% hands off, by implementing tightly controlled management systems and throughly vetted employees, it is possible to become very hands off and work almost entirely remotely (but keep a tight reign!)….which is handy when your off for a few days sailing

Very true Andy. Our biggest worry with newbie investors is many of them are taught to think real estate investing is passive and this simply is not true. ESPECIALLY for new investors and one’s that don’t yet have the right power team in place and systems setup. Usually the full team (accountant, bookkeeper, lawyer, realtor, property manager, insurance broker, mortgage broker, etc.) isn’t setup until after several properties are bought – same with all the online technology.

Thanks for sharing and commenting! And enjoy sailing while you (and your systems) make you money through real estate!